In a recent update, we wrote about the concept of Market Breadth, which as a reminder, is the number of stocks advancing versus declining in a particular index. We mentioned that market breadth had been declining, meaning more stocks were declining while the market has moved sideways for the last month. Here is what we wrote in a previous update about the current state of market breadth:
“This negative divergence makes some sense when looking at sector leadership. The S&P 500’s largest sector is Information Technology, accounting for 26% of the index’s market capitalization… Right now, only six of the eleven sectors are in what Canterbury defines as a “Bull Market State” or low risk market environment. Those six sectors account for 67% of the index’s market capitalization. In summary, if you have a large sector leading the markets, while a third of the index is in a Bearish or Transitional Market State, it is logical that market breadth shows a negative divergence.”
In this update, we are going to add some color as to why market breadth is weaker by showing where market strength has been recently, and which market segments are still struggling from more bearish market characteristics.
Let’s start with the S&P 500 sectors. We talk about this a lot by mentioning which sectors are leading and lagging. The table below shows the sectors, which are ordered by their “volatility” or risk-adjusted ranking. This is a relative strength indicator used by Canterbury that also takes a security’s current level of volatility (risk) into account. It also shows the “Market State” environment for each sector. For reference, Market States 1-5 are “Low Risk,” Market States 6-8 are “Transitional” (risk is falling or rising), and Market States 9-12 are “High Risk.”
Source: Canterbury Investment Management
As you can notice from the table, six of the eleven sectors are in a Low-Risk Market State. Three of the sectors are in a High-Risk Market State. The top six risk-adjusted ranked sectors make up 70% of the S&P 500’s market capitalization. The top three ranked sectors alone make up 42% of the index. Heavier market components are leading on a risk-adjusted basis. Additionally, Financials is a sector that has a low ranking and is showing High-Risk characteristics. This is also a sector that has several stocks. In other words, based on the number of stocks in the sector, Financials lagging would have a large contribution to declining market breadth.
Now, if we shift our focus to style indexes, we can see that there is a disparity between the different sizes of stocks and what type of environment they are in and how they rank. Large cap stocks (those stocks in the S&P 500) as a group have performed better than midcaps and small caps. Both Large Cap Growth and Large Cap Value are leading the other styles in terms of risk-adjusted rank. For each category (large cap, mid cap, small cap), growth stocks (generally technology stocks) are leading value stocks (usually financials and industrials).
Source: Canterbury Investment Management
One of the main reasons we are seeing declining market breadth is due to where the majority of market strength has been. Markets have tended to favor technology-oriented and growth sectors, which are generally larger market components.
Additionally, market strength has been mostly in those larger capitalized, more established stocks. Small cap indexes are in High-Risk market environments. As an index, the S&P 500 doesn’t look all that bad right now since technology stocks have carried it in 2023. An index like the Russell 2000, which represents small cap stocks and several of those “regional banks” you keep hearing about in the news, has shown higher risk, bearish characteristics.
This update focused on domestic US stocks, but in other news, international stocks continue to benefit from a weak US dollar. Our rankings list has been dominated by international countries and foreign geographic regions. The MSCI Mexico Index just broke out to its highest point since 2015. After the surprising negative news regarding Credit Suisse a few months ago, the MSCI Switzerland Index has had a sharp rally. The Canterbury Portfolio Thermostat has adapted its holdings to favor some international securities, as well as more technology-oriented US sectors.